Investors & landlords

Sounds like you got a handle on it now. One thing I can provide you a bit more information on, is concerning your acquisition of the property.

If the property is gifted to you, then as stated before you are also gifted the original cost basis and all prior depreciation taken.  Here's a sample scenario of how that can kill you when you sell the property in the future. My numbers are guestimates, but close enough to help you "see" this.

- Originally purchased by step-dad in 2000 for $50K with 40K allocated to the structure and $10K allocated to the land. So the $40K is what gets depreciated over 27.5 years.

Step-dad gifts you the property 2020 at which point the FMV of the property is $200K. But you don't get that cost basis since it's a gift. He has already taken $25K of depreciation over the prior 20 years he owned it.

When you enter this on your return, you have to reduce the cost bases of the structure ($40K) by the amount of depreciation already taken. So your cost on the entire property is now $25K with 10K allocated to the land and you will start depreciation all over again on $15K over the next 27.5 years.

In 2025 you have taken $5K of depreciation and you sell the property for $250,000. Your adjusted cost basis in the year of the sale is $25K minus the 5K of depreciation you already took, making your adjusted cost basis $20K. So with a sale price of $250,000 not only do you have a $230,000 taxable gain on the sale, that gain also gets included in your AGI and you will be in the highest tax bracket.

----------------------------------------------

The other option is that you purchase the property from your step dad at it's current FMV ($200K in my ficticious scenario) which means when you sell in 5 years for $250K you may have taken maybe $10K in depreciation. That makes your adjusted cost basis for the sale $190K giving you a $60K gain, which has a better chance of keeping you in a lower tax bracket. Of course, that depends on your other sources of income too. If your income would be say, $160K before taking the rental into account, then it really won't make that much of a difference to matter.

----------------------------------------------

The third option is that your step-dad leave it to you in his will and you inherit the property after he passes. But depending on his current age and health, that could be really long time. However, if you inherit property, your "cost basis" is the FMV of the property on the date of his passing (not the date you actually get legal ownership of it.) So if he passed away today, the FMV of the property in my ficticious scenario would be $200K and that's your cost basis "forever" so long as you own the property. So if after inheriting it you turned around an immediately sold it for $200K, every single penny of that $200K would be tax free income. You would only pay tax on any amount "over" $200K if you sold it for more than the cost basis established upon the passing of your step dad.

-----------------------------------------------

The fourth option is an Seller financed sale. I myself am totally against seller financed sales of real estate, because in my limited experience with them (not my personal experience, but the experience of those I know who have done this) the foreclosure rate on a seller financed sale is 100%.  Generally, the probability of the buyer stopping payments in the first two years are above 90%. THe changes if the buyer stopping payments in the first 5 years are 100%. Payments stop for a number of reasons, the primary one being that the buyer loses their employment, and the 2nd most common reason being that the buyer dies, and the spouse or those who inherit the estate of the deceased doesn't have the means to continue payments.

However, a seller financed loan is an option that even though I"m biased against them, I don't see that as a valid reason to deny you or anyone the possibility for their personal consideration. With a seller financed loan it should still be handled by a real estate attorney to ensure all the paperwork is in order on the legal front, so that the buyer can claim all those expenses that go with home ownership - such as the mortgage interest deduction. This is something that I would not expect a CPA or tax preparer to kn ow that much about beyond the tax aspects. For the legal aspects you'd really need to seek out a real estate attorney.

Just be aware that even on a seller financed loan, if you default on the payments it "will" destroy your credit. But by the seller financing it at the current FMV they can choose to claim their taxable gain all at once (bad idea) or over time as they collect it, thus keeping them in the lower tax bracket area.

For the buyer, if you buy at the current FMV of the property ($200K in my fictitious secenario) you get what you paid for the property as your cost basis, and don't have to wait for your step-dad to die to get that cost basis upon inheritance.